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The Indian equity market, characterized by a sell-on-rally pattern over the past four to five months, has exhibited signs of improvement in the last two weeks. However, it remains too early to definitively declare a shift from a sell-on-rally to a buy-on-dip strategy. The current market environment is considered more favorable due to more balanced valuations and a positive long-term economic outlook. The Union Budget, particularly its impact on consumption and capital expenditure, is seen as a contributing factor to this improved outlook. The 0.3% of GDP tax cut, benefiting salary earners, is anticipated to boost consumption in FY26-27 and have a multiplier effect on the economy in the medium term. Although the capital expenditure plan falls short of the long-term average, it's not expected to significantly hinder long-term growth, especially with projected 10.1% growth in FY26. The combined effect of increased consumption and sustained capital expenditure presents a positive scenario for the Indian economy.
Despite the positive budget framework, the market's gains were hampered by global disruptions stemming from the announced “Trade War.” The imposition of tariffs by the US on Mexico, Canada, and China created uncertainty in global markets. While the tariffs (except those on China) were temporarily put on hold, global sentiment remains cautious. There's a growing perspective that the US is using tariffs as a warning tool, and if this becomes a normalized aspect of US policy, it could lead to a more stable global market, with upside potential dependent on economic data and rate policy. It is widely believed that the ongoing trade disputes will ultimately benefit no one, posing a significant threat to global economic growth and potentially causing investors to seek safer assets. Protectionist measures threaten the efficiency of global trade, leading to inflation and higher interest rates; however, global pressure is expected to mitigate the extent of protectionism.
The Reserve Bank of India's (RBI) actions to increase financial liquidity through open market operations (OMO) and potential rate cuts are viewed positively for the domestic economy. Expectations are rising for a more accommodative monetary policy under the new governor, Sanjay Malhotra, driven by factors such as moderated economic growth (5.4% real GDP growth in Q3FY25), reduced inflation, and the elevated bank rate (held at 6.5% for the past two years). The market anticipates a total of 50-100 basis points (bps) in rate cuts during 2025. However, this is contingent on several factors, including the volatility of the Indian Rupee (INR), which has depreciated significantly in recent months, and the Federal Reserve's rate cut policy, which remains uncertain due to trade war risks. Despite a conducive economic environment for future growth, the stock market remains hesitant, as earnings growth is perceived to be below historical trends. Current valuations, while lower than last year, are not fully justified given the low earnings trajectory. While Q3FY25 showed a broad market PAT growth of 9%, the one-year forward P/E ratio is more than double at 19x. However, Q4 is expected to show improvement, driven by government spending and moderated external inflation. For FY26, earnings growth is projected at 12-13%, an improvement from the 8-9% projected for FY25. A return to the long-term average earnings growth of 15% could signal a potential market recovery.
The divergence between positive economic fundamentals and cautious market sentiment highlights the complexity of the current situation. The potential for RBI rate cuts offers a significant boost to the domestic economy, mitigating the impact of global uncertainties. The success of this strategy will, however, depend on the effective management of inflation and currency volatility. The author, Vinod Nair, Head of Research at Geojit Financial Services, offers valuable insights into the intricate interplay of domestic and global factors affecting the Indian equity market. His analysis emphasizes the importance of closely monitoring global trade dynamics, inflation levels, and RBI policy decisions in order to navigate the current market environment effectively. The uncertainty surrounding the trade war and its potential long-term impacts adds another layer of complexity, requiring a nuanced approach to investment decisions. While the long-term prospects for the Indian economy remain positive, the short-term outlook is heavily influenced by these external factors.